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WEBINAR EXECUTIVE SUMMARY

How to Nudge Your Clients into Better Retirement Decisions

KEY TAKEAWAYS

  • Humans aren’t rational decision makers. Nudges can propel them to better decisions.
  • Choice architects organize the context in which people make decisions.
  • Stage 1: Motivating clients to make a change.
  • Stage 2: Optimize and help clients identify options.
  • Stage 3: Support clients in realizing the best decision.
  • Stage 4: Monitor progress and adjust as needed.

Great-West Financial recently formed a strategic collaboration with the Stanford Center on Longevity.

Financial planners can benefit from Stanford’s research on aging and retirement, such as the MORE framework for better financial outcomes. Lessons from behavioral economics can help financial advisors steer clients to better decisions. Savvy advisors recognize common biases and use “nudges” to guide clients during retirement planning.

Presenters

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How to Nudge Your Clients into Better Retirement Decisions

In our recent webinar, Sasha Franger and Nag Odekar discussed the effect of behavioral biases on retirement planning. They described how behavioral economics and nudges can steer clients to better investment decisions.

Humans aren’t rational decision makers.
Nudges can propel them to better decisions.

Humans typically make 10,000 decisions per day or approximately 5.8 per second. Conventional economic theory suggests that people are rational actors who make logical decisions. But, this isn’t true. Behavioral economic theory has found that 95% of decisions are based on intuition and “what feels right” or is “good enough.”

Nudges reframe what people are inclined to choose and steer them toward better decisions. Nudge theory was developed by Dr. Richard H. Thaler, winner of the 2017 Nobel Prize for Economics. His research found that people depart from rationality in consistent ways. Irrational behavior can be anticipated and modeled.

Nudges alter behavior in predictable ways, but don’t limit or forbid choices.

Three types of nudges are:

Researchers found that if healthy food is put at eye level in school cafeterias, kids are more likely to buy it. Convenience makes certain choices more likely, without limiting choices.

In countries that default people into organ donation programs, participation rates are close to 100%. In countries where people must opt in, participation rates are less than 30%. Default options for workplace retirement plans have been studied extensively. Employees are more prepared for retirement when plans have default features like auto enrollment and auto escalation.

Framing is how options are presented. For example, if patients are told that 90% of people who have a surgery are alive five years later, they are more likely to have surgery than if they are told that 10% of people are dead five years after the procedure. Although the odds are the same, the framing makes a significant difference.

“A nudge, as we will use the term, is any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives.”

Dr. Richard H. Thaler, winner of the 2017 Nobel Prize for Economics.

Choice architects organize the context in which people make decisions.

In these examples, schools, governments, and doctors are the choice architects. Choice architects have great responsibility. Dr. Thaler has identified three guidelines for choice architects to follow.

Financial advisors act as choice architects for their clients. Advisors can use nudges to help clients make good decisions. The Stanford Center on Longevity’s MORE framework can be a useful tool. This four-stage process is composed of Motivate, Optimize, Realize, and Evaluate. The MORE framework helps people overcome behavioral biases and steers them toward better decisions.

Dr. Thaler has identified three guidelines:

  • Nudges should be transparent and not misleading.
  • It should be easy for people to opt out of a nudge.
  • Nudges should be designed in the best interest of those being nudged.

The Four-Stage Process is Composed of:

STAGE 1

Motivate

STAGE 2

Optimize

STAGE 3

Realize

STAGE 4

Evaluate

STAGE 1: Motivate

Motivating clients to make a change.

The first stage is Motivate. Financial advisors must make clients aware that a problem exists and requires action.

Despite these biases, there are two effective ways to nudge clients into recognizing that maintaining the status quo is a bad idea:

Connect Emotionally
Rather than focusing on finances, connect to the client’s life goals and ambitions. Ask about personal objectives. Preparing for retirement isn’t just about money.

Be a Storyteller
People remember stories more than statistics. Avoid product pushes. Clients must first realize they need to make a change.

Common behavioral biases:

  • Feeling vs. Thinking
    People often make decisions based on a sense of what feels good or bad.
  • Unrealistic Optimism
    People frequently believe they will experience more positive outcomes and less negative outcomes compared to others.

“The Motivate stage is the time to focus on your client’s life goals. Don’t present financial solutions. For most clients, preparing for retirement is about not just preparing for money, but also preparing for all the other things that come with retirement.”

Sasha Franger, Director of Thought Leadership, Great-West Financial

STAGE 2: Optimize

Optimize and help clients identify options.

The second stage is Optimize. Advisors assist clients with gathering facts, learning about strategies, and identifying options. They help clients build their decision-making capability. As the choice architect, financial advisors must organize information to lead clients to decisions that are in their best interest.

Researchers have identified three nudges that help people optimize decision making:

Present the Best Choice First
People usually perceive the first option as the optimal choice.
Explain What Peers are Doing
People want to fit in and try to act in accordance with social norms. A best practice is discussing products that other clients use successfully.
Frame Options in Terms of Loss
People are more motivated to avoid a loss than to pursue a gain.

Common behavioral biases:

  • Confirming Personal Bias
    People seek out and favor information that corroborates their own beliefs. They may ignore contradictory behavior. For example, clients may focus on information that confirms their current investment strategy.
  • Choice Overload
    People have difficulty making choices when faced with too many options. This is called “analysis paralysis.”

STAGE 3: Realize

Support clients in realizing the best decision.

The third stage is Realize. Financial advisors assist clients in reaching a decision and implementing it.

Two nudges help clients realize the rational choice:

Make it Easy
People are more likely to take action when they are clear on what they must do.

Set the Default
People typically remain with the default choice that is presented to them.

Common behavioral biases:

  • Inertia
    People are reluctant to change.
  • Inconsistencies Across Time
    People often say they will do something in the future, but fail to do it when the time comes.

“Effective financial advisors recognize that nudges drive rational behavior. They act as choice architects and use the four-stage MORE process to help clients make better decisions.”

Nag Odekar, Vice President, Marketing, Individual Markets, Great-West Financial

STAGE 4: Evaluate

Monitor progress and adjust as needed.

The final stage is Evaluate. After clients make a decision, financial advisors monitor performance and recommend adjustments.

The best nudge in this phase is positive reinforcement. Financial advisors must validate their clients’ decision and underscore why it was in their best interest. Storytelling and framing of loss aversion can also be helpful. The goal is to point out previous healthy behavior and encourage clients to repeat it.

Common behavioral biases:

  • Repetition Exhaustion
    People tend to tune out messages they hear too often.
  • Old Habits Die Hard
    Without outside help, people often fall back on biases.

CASE STUDY

Using the MORE Framework

To illustrate the MORE framework in action, Nag Odekar used the example of Roger and Jeanine who are 65 years old and approaching retirement. They have $1 million of investable assets, but no plan for guaranteed income in retirement other than Social Security. Their financial advisor wants to motivate them to incorporate a guaranteed income strategy into their portfolio.

Talk about what longevity really means. According to the Stanford Center on Longevity, people need three things to live well longer: a sound mind, physical strength, and financial stability. These factors are linked; if one weakens, the others may as well. Roger and Jeanine’s financial advisor asks what they are doing to prepare for each aspect of longevity.

Discuss retiree expenses. Stanford’s research has found that 56% of people haven’t calculated how much money they will need in retirement. Only one in three pre-retirees has a plan for how much money they will spend annually. Roger and Jeanine’s advisor discusses their anticipated weekly and monthly expenses in retirement, as well as variable expenses.

Fig. 1: Budgeting and Retiree Expenses (view diagram)

Highlight that mobility and a diverse social portfolio enhance longevity. Roger and Jeanine’s financial advisor encourages them to track their physical preparation for retirement just like their financial preparation. The financial advisor may also emphasize the importance of social interaction.

Tell stories about increasing life expectancies. Teaching clients about life expectancies can illustrate the need for a guaranteed income strategy. Back up statistics with stories. Former President Jimmy Carter, for example, is 93 and still working on Habitat for Humanity projects.

After presenting a guaranteed income strategy first, Roger and Jeanine’s financial advisor highlights that 85% of Baby Boomers believe a guaranteed source of income in retirement, in addition to Social Security, is important. Other best practices in the Optimize stage include:

  • Explore risks clients are willing to take, while discussing preferences. Preferences relate to risk management (e.g., sequence of returns, inflation, longevity), goal achievement (e.g., liquidity, security, bequest), and investments (e.g., fees and expenses).
  • Ask what clients have insured right now. Clients are familiar with insurance for their cars, house, or health. Yet, they may not understand that many types of savings like mutual funds, IRAs, and 401(k)s are not insured.

To overcome inertia, Roger and Jeanine’s advisor shares hypothetical portfolios with them. The example below is based on five portfolios of $1 million which exclude Social Security. Income models illustrate how different product allocations affect retirement income.

The advisor explains how preferences and risk tolerances factor into each hypothetical portfolio. He or she also shares what hypothetical product allocations look like at different points during Roger and Jeanine’s retirement, such as at 65, 75, and 85 years old.

Fig. 1: Hypothetical Product Allocation Options (view diagram)

In this final stage of MORE, Roger and Jeanine’s advisor explains his or her role and reinforces that he or she is their choice architect. A best practice is underscoring that a good financial advisor takes all aspects of a client’s life into account, including life coaching, longevity expertise, and portfolio planning.

Roger and Jeanine’s financial advisor emphasizes that retirement has many stages. As a result, spending patterns and savings strategies must change with age. Over time, Roger and Jeanine must re-evaluate their portfolio.

The financial advisor/client relationship doesn’t end with a product purchase. Roger and Jeanine’s advisor teaches them how to read their statements, so they can focus on their goal of guaranteed income.

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